Small Business

6 Things To Do Before You Buy a Business

En español | A year ago, Nick Montalvo had the opportunity to buy a frozen yogurt store at a mall in Corpus Christi, Texas. His initial franchise business venture was very successful, so he decided to buy a similar business on North Padre Island along the coast of the Gulf of Mexico, near Corpus Christi.

Montalvo, 51, decided to turn his acquisitions into a family business and handed over his stores to his two daughters, to help them financially. Although Montalvo trained as a machine tool operator, he spent his entire career buying and selling real estate. Now, with his daughters, he also manages the frozen yogurt businesses.

1. Launch a broad search.

When it comes to types of businesses and industries, there are many options. Experts recommend that the business be related to your experience and skills, since its success will greatly depend on the owner's knowledge. "It's important to become familiar with the specific type of skills required to manage each type of business," says Bob House, general manager of BizBuySell, the main web platform for buying and selling businesses in the U.S.

As far as skills go, do not get confused. "If you like cooking, that doesn't mean that a restaurant is your type of business. In managing a restaurant, there are many other things that are essential for success, like handling the constant staff turnover," says Joe Harper, director of the Small Business Development Center of the U.S. Small Business Administration (SBA) in Texas.

BizBuySell.com includes information about the businesses bought and sold every year on the site, their values, the type of industry and other key financial information for the small business market.

2. To buy or to create a new business?

Consider the risks. Launching a business from scratch is riskier than buying an established one. "Statistics show that the likelihood of failing with a start-up business is higher than when buying an established one, and the risk is even lower if you buy a franchise with a proven model for a product or service," says David McCready, president of Transworld Business Advisors, a business brokerage firm in South Texas. The Transworld Business Advisors website includes a list of tips to find the right business. Every state and territory has a federal agency for economic development that provides counseling, training and financing services to entrepreneurs with various experience levels.

3. The prospects of the business.

Of course, no one wants to buy a business that's going downhill. For example, says House: "No one today would think of buying a movie rental business, which is a sector that is becoming extinct."

Before buying the two frozen yogurt stores, Montalvo looked at sales tax reports and cash register reports. "Those don't lie," he says. Also, as a real estate expert, Montalvo placed a special emphasis on the location of the business and bought the second yogurt store in a tourist location that is close to a water park. He hopes those two factors provide good prospects for sales growth.

4. The value of the business.

How much a business is worth is one of those things about which experts disagree. There are many ways to estimate this. One is the cash flow that the business generates or what the owner has left as profits after paying all the expenses. According to BizBuySell's statistics, in the United States, small businesses on average are purchased for the equivalent of between two-and-a-half and three times their annual revenues. The average value of a small business is $200,000.

But there are other ways to look at value. When he bought the frozen yogurt stores, Montalvo used a different approach; he determined how much it would cost to launch the business from scratch, including equipment, freezers, furniture, cash register and more. According to this entrepreneur, the cost came close to $150,000. Since the business he just bought was below that value, he thought it was a great opportunity.

House suggests combining various value approaches, like the amount of revenue with the value of assets or equipment, and the sales level. According to BizBuySell, on average, small businesses are sold for the equivalent of between 0.8 and 0.9 times the annual sales of the business. The Collin Small Business Development Center in Plano, Texas, offers a list of the main methods to value a business.

5. Surround yourself with experts.

It is very important to have a team of experts analyze the business you want to purchase. Attorneys, accountants, experts in that business, and even relatives and friends can help you better understand the business and perform due diligence to make sure that the business actually sells what it claims and does generate certain earnings.

6. Understand the numbers well.

"It's essential to understand what cash flow is and how it is generated, and the real profits that the owner is going to take home," McCready says. "Many buyers overlook the fact that revenue is seasonal (there are good and bad months) and aren't ready with a reserve to face the normal cycles of a business."